Skip to 0 minutes and 1 secondMARTIN UPTON: Can you tell us about the new approach to regulating financial firms since the financial crisis? The 'Arrow' regime is now being superseded - how are things different?

Skip to 0 minutes and 10 secondsCHRIS WOOLARD: So we have a significant focus on two things really. So the first is we look very closely at a risk based model of regulation, so we are looking at where are the greatest detriments that might see in the market and we are targeting resources at those. The second thing that we're doing more of is really looking at the question of conduct and the responsibility of senior managers within firms for the conduct of those firms and I think that's quite a shift in emphasis.

Skip to 0 minutes and 40 secondsMARTIN UPTON: You're introducing a new senior manager's regime for senior officers within financial firms and that's replacing the old approved person's regime. But is it really any different?

Skip to 0 minutes and 52 secondsCHRIS WOOLARD: I think it certainly is. I mean the biggest single reform that I think we will take out of the new senior managers regime is much more clarity up front um who is responsible for what within firms. Under the old regime, although you might be an approved individual sometimes the lines of accountability are very blurry quite often you know split between a number of individuals, the new regime makes it much easier to take a view from day one who's responsible for particular activities and what their responsibilities are.

Approving the firm and its senior managers

In the video, Chris Woolard, director of strategy and competition at the FCA, talks about the new Senior Managers Regime that is used to assess the competence, and understand the responsibilities, of key post-holders in financial firms.

The process of defining a regulated activity involves the following two steps:

  1. The activity has to involve certain defined financial services products. These are known as the ‘specified investments’.

  2. The actual ‘activity’ being undertaken in respect of these ‘specified investments’ has to be defined (borrowing, lending, investing, insuring, etc.).

There are, however, some specific exemptions where firms undertaking regulated activities do not need authorisation as their activities are subject to supervision by other regulatory bodies.

Conducting business in regulated activities without authorisation or exemption, or without an exclusion applying, is a criminal offence under the Financial Services and Markets Act 2000. Offenders can receive unlimited fines and jail sentences of up to 2 years. Contracts previously agreed under these circumstances are unenforceable.

What do the regulators do ahead of granting permissions for firms to undertake regulated activities? First, there are five ‘threshold’ conditions that the applying firm must meet. These are designed to promote financial safety and soundness. They are:

  1. A firm’s head office, and its ‘mind’ and management, must be in the UK if it is incorporated in the UK.

  2. A firm’s business must maintain appropriate financial and non-financial resources.

  3. The firm itself must be ‘fit and proper’ and be adequately staffed.

  4. The firm and its group must be capable of being effectively supervised.

  5. The firm’s business model must be suitable for the regulated activities it seeks to carry out.

Source: Adapted from Bank of England and FSA (2012, p. 8) and CISI (2015, p.12).

The ‘fit and proper’ test does not just apply to the firm as a whole, but is also applied to the specific employees within it that perform certain key controlled functions. Until March 2016 these controlled functions were divided between what were known as:

  • significant influence functions (SIFs), where the activities of these individuals can materially impact upon their firm’s business affairs

  • the consumer function, which relates to arranging transactions and managing investments where there is contact with customers (e.g. investment advisers and mortgage advisers).

To undertake these controlled functions, individuals had, until 2016, to be designated as ‘approved persons’. From March 2016, the ‘approved persons’ regime was superseded by the Senior Managers Regime (SMR). This requires that all those in a senior management function (SMF) are required to have their responsibilities and reporting lines mapped out, and are required first to be vetted via internal procedures by the firm before subsequently being approved by the regulators.

In applying this new ‘fit and proper’ test to those seeking ‘SMF’ status, the regulators check for evidence about their competence and experience – specifically in relation to the management responsibilities that they wish to fulfil. Second, the regulators assess the integrity, reputation and financial soundness of the individuals by checking, for example, if they have ever been made bankrupt.

Once the regulator has satisfied itself that the ‘fit and proper’ test has been passed by those who are to undertake the SMFs, and also satisfied itself that the five threshold conditions have been met by the firm, permissions to undertake the specified regulated activities can be given. The firm thus becomes authorised to conduct those areas of financial services business that fall within the scope of their permissions.

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This video is from the free online course:

Finance Fundamentals: Financial Services after the Banking Crisis

The Open University